Financing Risk and Innovation

Ramana  Nanda; Matthew  Rhodes-Kropf

Article | Management Science | April 2017

Financing Risk and Innovation

by Ramana Nanda and Matthew Rhodes-Kropf

Abstract

We provide a model of investment into new ventures that demonstrates why some places, times, and industries should be associated with a greater degree of experimentation by investors. Investors respond to financing risk―a forecast of limited future funding―by modifying their focus to finance less innovative firms. Potential shocks to the supply of capital create the need for increased upfront financing, but this protection lowers the real option value of the new venture. In equilibrium, financing risk disproportionately impacts innovative ventures with the greatest real option value. We propose that extremely novel technologies may need "hot" financial markets to get through the initial period of discovery or diffusion.

Keywords: Risk and Uncertainty; Financing and Loans; Innovation and Invention;

Format: Print

44 pages

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Citation:

Nanda, Ramana, and Matthew Rhodes-Kropf. "Financing Risk and Innovation." Management Science 63, no. 4 (April 2017): 901–918.

Chai Point is India’s largest organized chai retailer. It has missed its target for retail store openings by approximately 25%, goals that are very important to its investors who are also their board members. However, it has developed an exciting new Internet based tea dispenser, that has the potential to dramatically increase Chai Point’s market opportunity and growth rate but can be seen as a change in their growth strategy. The founder needs to decide his strategy for his next board meeting. Should he focus on their past performance? Or should he spend time outlining boxC.in’s technology and potential, since this will be the first time that the institutional investors will be seeing this new capability?

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